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Islamic finance debate
Prospects and problems of
Shariah-compliant finance
The market is growing fast in Muslim countries and among Muslim communities.
Its fuller development, Euromoney’s roundtable of experts suggests, depends
on clearer views on objectives, further development of regulation and
standardization of products and approaches
MNA, AAOIFI Islamic finance – meaning instruments deemed sufficiently Shariah-compliant by some group of Shariah scholars – has
been around for quite a while now. How successfully is it developing
– are we talking about a niche market or a mainstream market?
KH, CBB A mainstream market has established practice, diversity of
product, defined laws and regulations and a critical mass of players.
Defined like this, Islamic finance is still a niche market. There are too
many loopholes in terms of the practice, in terms of the laws and
regulations and in terms of critical mass – so far the largest tickets
have been through Islamic windows, not Islamic banks. We are not
yet a mainstream market.
AAK, GBCorp I would say that Islamic banking is evolving at a very
steady pace, and as in any evolutionary process it is also subject to
great challenges. Due to its interest rate neutral characteristic, the
current stressed market has catalysed this growth process so it will
have a much bigger global presence and we will see Islamic finance
tapping into newer sectors in the industry. But the greatest challenge to Islamic banking comes not from outside market influences
but from within.
MNA, AAOIFI Nik, how do your investors react to Islamic instruments
or Shariah-compliant instruments?
NNT, DIFC The key things that I come across in meeting various investors – especially those who are new to Islamic finance or Islamic
financial institutions – are simply the elements that are unfamiliar
in non-Islamic transactions. So the avoidance of usury, avoidance
of gharar (excessive speculative risk), avoidance of unbundled risk
such as gambling (maysir), and the illegal sectors (haraam) activities.
The mixing of moral issues, social justice and financing creates the
structures and these structures are complex and unfamiliar to new
investors. For example, there must be underlying assets for transactions, an idea primarily driven by the rationale in Islamic law that
borrowers do not over-borrow.
These principles are the kinds of things that tend to be discussed
more when I talk to various investors who are interested in Islamic
finance, and it is important because of what it basically does – it links
finance with the productive flows of the economy. That message has
gone across very well but the source of unfamiliarity is how products
are structured to meet these objectives.
MNA, AAOIFI So do you feel that one attraction of Islamic financing is
this notion of more ethical financing structures?
AAK, GBCorp I would say that ethical financing in relation to Islamic
finance is not just notional but fundamental. The ethical financial
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Executive summary
• The Shariah-compliant finance sector is growing fast but remains
a niche market
• Putting in place a financing system that is both Shariah compliant
and produces a return for investors is a challenge
• Regulators in a Shariah-compliant system require more
transparency from banks than in a non-Shariah system as investors
bear relatively more risk
• The Shariah-compliant system readily attracts those for whom it
is a vital component of their faith but much of the growth in the
market is coming from neutrals who find that the system can deal
with the majority of their banking needs
• Shariah-compliant finance has proved immune to the direct
impact of the sub-prime-induced credit crisis but cannot escape
entirely the broader macroeconomic effects
• A secondary market in sukuk is emerging only slowly
• Standardization is a crucial but highly challenging issue in
Shariah-compliant markets
structure is what differentiates Islamic banking from conventional
banking. Ethical banking does not just mean that we do not participate in transactions that are deemed ‘non-Sharia compliant’, such as
dealing in alcohol, gambling, drugs, etc, but it goes beyond that to
encompass a structure that is fair in its transparency, risk mitigation
and asset-backed transactions. This is evident in Islamic banking’s
approach towards profit sharing, taking into account the client, the
market and the sector.
The challenge
ND, Trowers & Hamlins I think one of the questions we probably
ought to be asking is whether we think that goal or that principle is
genuinely being pursued through the Islamic finance market, or the
Shariah-compliance market, whichever terminology we wish to use.
From · EUROMONEY · December 2008
Mohamad Nedal Alchaar (MNA – chair)
is the secretary general of Accounting
and Auditing Organization for Islamic
Financial Institutions (AAOIFI). He
was director of market performance
analysis at Fannie Mae, and previously
vice-president at Johnson & Higgins
in Washington, DC. He also taught for
several years at George Washington
University, where he received a PhD in
monetary economics.
Nik Norishky Thani (NNT) is the
executive director of Islamic finance at
Dubai International Finance Centre.
He has more than 10 years’ experience
in advising and structuring Islamic
financial instruments, in particular
Islamic sukuk. Before joining DIFC he
was head of Islamic capital markets for
MIMB Investment Bank Malaysia and
Bank Islam Malaysia Berhad.
Ahmed Al Khan (AAK) joined Global
Banking Corporation as head of
investment banking with more than 10
years’ experience in financial services,
including working in New York. He
is on the boards of various leading
establishments in the Middle East. Before
joining GBCorp, he was chief executive
of Diyar Al Bahrain.
Khalid Hamad (KH) is the executive
director of banking supervision at the
Central Bank of Bahrain where he has
held several senior posts. His present
responsibilities include supervision
of all banking institutions, including
Islamic banks, as well as inspection of
all financial institutions, comprising
banks, insurance firms and capital
market players. He is chairman of the
IIFM, and chairman of the Waqf Fund
for research, education and training in
Islamic finance.
Afaq Khan (AK) is chief executive of
Standard Chartered Saadiq, the global
Islamic banking business of Standard
Chartered Bank. He joined Standard
Chartered in 2003 with the mandate to
launch the Islamic business division.
Since then, he has been responsible
for the strategic build-up of a global
Islamic banking business covering retail,
corporate and investment banking.
Neale Downes (ND) is a partner in the
international finance group of law firm
Trowers & Hamlins. Particular areas of
expertise include asset-backed and assetbased financing, syndicated lending,
and project and other leveraged and
structured finance.
Ijlal Ahmed Alvi (IAA) is the chief
executive of the International Islamic
Finance Market (IIFM). He has more
than two decades of experience, mainly
in treasury, capital markets, financial
institution set-up and reorganization.
He manages IIFM’s global working
groups on standardization of Islamic
documents, products and practices. He
has recently overseen the launch of the
first standardized treasury murabaha
documentation.
From · EUROMONEY · December 2008 www.euromoney.com
photography: fransisco fernandez
Participants
Islamic finance debate
The challenge is to put in place a system of financing that is in
compliance with the Shariah and in compliance with relevant laws
and regulatory constraints but which also produces a return. Islamic
banks have shareholders and while, in theory, those shareholders
accept the notion that their capital should be more at risk than the
capital of the investors and shareholders in their conventional counterparts, I am not sure if that is genuinely the case if you look at how
the market has developed.
People are beginning to scrutinize Shariah compliance more
carefully. Obviously the AAOIFI pronouncements in January and
the discussions that took place in January and other more general
continuing debates are trying to bring people back to what is at the
core of this industry. Yes, it is to provide movement of capital, it is
to provide finance, but should it be providing finance for homes,
for hospitals, for schools, for universities, or should it be providing
finance for institutional funds that are free then to do whatever they
like with the funds.
So it strikes me that one of the fundamental challenges is in complying with Shariah goals, while at the same time operating within
what has thus far inevitably been a conventional wrapper that has
potentially constrained market growth.
AK, Standard Chartered I don’t completely agree. If you look at the
liability side of the Islamic banks’ balance sheets, the profits that
they declare on their liabilities to the region’s customers are generally
speaking higher, which is proof that they are sharing the rewards.
MNA, AAOIFI Some people say that a sizeable share of the profit had
been generated by real estate investments.
AK, Standard Chartered But the fact remains that the profits are being shared.
MNA, AAOIFI I am going to play the devil’s advocate here, so whatever I say may not represent my own beliefs and convictions. From
what you are saying, it can be argued that Islamic banks’ customers are exposed to the economic and business cycles. Returns that
customers get depend on the performance of the Islamic banks’
investment portfolio, which in turn are directly affected by the
economic and business cycles. It depends on the skills of Islamic
banks in managing their investment portfolios to ensure that their
customers benefit fully from favourable economic conditions and
that they are not hugely adversely affected from unfavourable
economic conditions.
AAK, GBCorp Market fluctuation is an accepted fact of the economic
cycle. First of all, if we define the wave you are talking about we can
say that the markets are sometimes high and at other times low. In
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conventional banking the wave is created by speculation, where
when the market is high it is over-speculated, making it unreal, and
then going back to reality as it falls. However, in Islamic banking it
is not as pronounced because it is asset-backed, tangible and almost
capital protective, creating a certain cushion to it. Islamic banking
does not expose the investor to the speculative trail and even when
the market is high or low it is based on real price fluctuation.
IAA, IIFM Absolutely. I don’t think just because you have shared in
the higher profit you will share in the higher loss. That depends on
the portfolio you have created, ie, risk versus reward, ie, the higher
the risk, the more reward. As Islamic finance is an equity-based
system that should support a real economic activity.
MNA, AAOIFI Ijlal, how do you see the market?
IAA, IIFM I agree with Khalid that it is still a niche market. We don’t
have a wide range of products to the extent that it is hard, in some
cases, to manage liquidity by Islamic institutions due to the absence
of a wide range of liquidity management products.
In terms of Shariah compliance, generally the scholars are in
agreement with most of the basic principles and there is no difference of opinion; however, in certain cases there is difference
of opinion in interpretation, which is the beauty of Shariah as it
encourages innovation.
The crisis
MNA, AAOIFI Some commentators have suggested that because of its
structural differences from the conventional banking system, Islamic
banking systems are immune to the current crisis. What truth is there
in this statement?
AAK, GBCorp The entire financial system is cyclical and to assume
that Islamic banking is immune to the effects of any crisis would
necessarily mean that Islamic banking works outside these economic
parameters, which is not true. Islamic banking is immune to certain
interest rate risks but not to economic risk, and due to the market
being intertwined, interest-rate risk transcends to economic risk,
creating a certain level of exposure.
But Islamic banking enjoys an advantage in the sense that strict
compliance to Shariah guidelines offers Islamic banks an inherent
safety net. The market has taught us how to structure our debt and
weigh our investment and debt exposure.
IAA, IIFM I don’t think there is total immunity. First, the crisis
affects confidence, and confidence is important regardless of the
system. Second, the performance of the Islamic banks through the
crisis will depend on their exposures, such as real estate. However,
From · EUROMONEY · December 2008
Islamic institutions are not confronted with the issues such as overvaluation or speculation, which are the main cause of problems for
conventional finance, and their business activities are based on real
economics, be it real estate or trade finance.
AK, Standard Chartered To the extent that the Islamic finance industry and the players in the Islamic finance industry are part and parcel
of the real economy, it is naive to think that we will completely escape
the cycles of the real economy. To the extent that Islamic banks have
not been active in the sub-prime ABS market, because they could not
for Shariah reasons, they are immune.
Ultimately, though, the question goes to the heart of what target
market you have selected for yourself as an Islamic bank. What
customers within that industry have you selected for yourself? How
good a mudarib (partner) have we actually been? That is what could
differentiate the banks that do better compared with others.
Benchmarks
ND, Trowers & Hamlins One of the other areas where we have seen
it affecting our client base is that I think it is an accepted evil, or a
necessary evil, that most transactions into which Islamic banks enter
are still ultimately referenced to Libor, or one of the other prevalent
market benchmarks for interest rates.
Those costs, as we know, have been rising inexorably. We
also know that there are a number of banks that cannot fund
themselves or obtain funding at Libor, and in fact their costs are
considerably in excess of Libor. That creates a greater problem in
an Islamic context because it is not always the case that you are
able to, or your institution will allow you to, pass those additional
costs on to your customer in the way in which the conventional
banks will routinely do through market disruption clauses. So that
is a market problem that is affecting the banks, and it is not necessarily soluble in the same way that the conventional banks will
solve that problem.
NNT, DIFC Islamic financial institutions clearly avoided structured
mortgage products and this is because of adherence to the fundamental principles in Islamic finance – the avoidance of riba (surcharge, rent or fee), gharar, maysir and haraam activities. Sub-prime
mortgage financing and the subsequent structuring of such financing into CDOs would not have passed any one of the fundamental
principles in Islamic finance. However, we are not immune to this
crisis or to any other credit events that may occur in future. There
are several reasons for this. The first is, whether you are conventional or Islamic, there is always the danger of over-exposure to any one
From · EUROMONEY · December 2008 particular sector of financing. In Islamic finance, however, this can
be more acute as there is insufficient supply of investment products
resulting in bias towards certain sectors, such as property, resource
and energy.
Secondly, there are still differing standards between jurisdictions,
and so if and when damage occurs, you can’t really tell how far the
damage will go because of the different standards in practice now. For
example, there isn’t one universal accounting standard adopted by all
Islamic banks operating in different jurisdictions.
Thirdly, many Islamic financial institutions, as well as products,
have not seen a full economic cycle. There are still a number of new
Islamic financial institutions out there. Sukuk has never been tested
in a court of law in terms of ownership issues for example.
Fourthly, Islamic finance is still connected to the wider financial
system, so I would expect that in this crisis there would likely be an
impact on profitability for Islamic financial institutions because we
are part of the wider financial system. However, I don’t think there
would be an adverse impact effect on capital. Solvency would not be
the problem but there is the likelihood that the crisis will hit Islamic
banks’ bottom line.
ND, Trowers & Hamlins I am not sure that an inability or a prohibition on investing in a particular type of product, or being involved
in a particular type of activity, is necessarily the same as good risk
management or compliance.
The fact that Islamic banks, for example, haven’t been able to
take positions in the sub-prime market because those exposures
have largely been assumed through derivative product – that’s
accident rather than design. They haven’t been allowed to invest
in those products. That is different from actively choosing not
to do so. I think the point that you made and what we are saying
is that there are still inherent risks flowing from the asset classes
or the areas of investment into which they have put their capital
as an alternative – for example, real estate. Those asset classes, as
we are now beginning to see, are themselves likely to be subject
to a downturn. I think as regards Islamic banks it may actually
take a little longer to see whether they are going to be suffering in
the same way that their conventional counterparts are suffering
because of exposure of a different type, but ultimately to the same
underlying asset.
KH, CBB I think the issue needs to be argued from two perspectives:
concept and practice. If you look from a conceptual point of view,
I don’t see – I mean, maybe what we should say is that there is a
relative immunity. This relative immunity stems from the fact that
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Islamic finance debate
if you fully comply with Shariah and if you are subject to proper
regulations and that you employ good business practices, then
you can get relative immunity. But from a practical point of view,
an Islamic bank is, as Nik mentioned, part and parcel of the whole
finance framework. I think what has made the impact, significantly
less on the Islamic finance players is basically two aspects. One is
that they are not allowed to trade debts and they are not allowed to
basically be involved in direct finance, but have to be asset-based or
asset-backed finance.
IAA, IIFM And on the investor side there are safeguards too. As a
homeowner I cannot re-finance my asset simply based on a revaluation of that asset to extract equity from it.
MNA, AAOIFI Let me throw a provocative statement in here that
does not represent my own or AAOIFI’s views. Shariah-compliance issues have restricted the creation of derivative products
whereas these products have deep and liquid markets in conventional finance. Without derivative products, it may be difficult for
Islamic finance to bring about financial deepening to its market.
So, in the absence of all the tools that Islamic finance prohibits,
you are going to have a thin market, and thin markets are very
sensitive and volatile and subject to economic shocks. Any shock
that comes into the economy, which could be natural, just in the
course of the business cycle, will have an augmented effect on the
real economy because the market is so thin. How do you respond
to that? Khalid?
KH, CBB It’s a very difficult question to address, I have to admit,
but let’s go back to the late 1980s when there was nothing but the
murabaha, musharaka in Islamic finance. I remember one bank at
that time in Bahrain took the lead and invited scholars and bankers
from outside Bahrain to try to develop an Islamic version of the
inter-bank market. That meeting took less than five minutes and
they concluded that there is no way to develop an Islamic inter-bank
market. Now look at what is happening. You have a huge amount of
money being traded between the banks through commodity murabaha. That is in itself a development. Look also at sukuk. Back in the
1980s, we barely heard of sukuk insurance, but now we hear of really
very complex sukuk structures.
IAA, IIFM I agree, but it will be a very tough path but essential. We
need certain standards for broader market usage from Islamic standard-setting, each have specific mandates, as bilateral solutions do not
work for all the industry’s requirements.
AK, Standard Chartered I think we are developing fast. Today, you
can do Islamic derivatives for hedging purposes, for risk manage-
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ment purposes. It is allowed across geographies. We are leading
the way at Standard Chartered in profit and currency swaps, for
example.
MNA, AAOIFI But they are controversial, Afaq. They haven’t been
endorsed by Shariah scholars – very few.
AK, Standard Chartered You would be surprised. There is a lot of
commentary but we have done transactions in Malaysia, in Saudi
Arabia, in Abu Dhabi. For a speculator, of course, Shariah does not
allow their use, but if Islamic institutions are to prosper they need a
certain number of key tools. They are available today and a deepening of the market has to take place.
ND, Trowers & Hamlins I actually think developments have been
pretty rapid. Obviously it is still a relatively nascent market but, for
example, I think that the sukuk is actually going to prove to be, or
hopefully prove to be, a much more important instrument than commodity murabaha. Commodity murabaha really just addresses the
short-term liquidity among the banks.
I am also interested that you say that it is not possible to package instruments up and distribute or move capital through such
methods. There is no Shariah prohibition relating to securitization
or packaging. The problem is, rather, an inherent legal problem
in terms of achieving what lawyers would call a true sale. That has
been the historical driver behind securitization in the conventional
banking and debt capital markets – genuinely to get assets/liabilities
off your balance sheet. Certainly from a Shariah perspective, you can
do Islamic securitization. Sukuk also has the potential to become a
much more important instrument than commodity murabaha in
terms of asset/liability management.
Differences
MNA, AAOIFI So, after all this development and inclusion of derivative products, how would Islamic finance differ from the conventional market? Will Islamic finance be able to preserve the Shariah
requirement relating to gharar, jualah (fixed payment) and maysir,
which are at the core of the definition of uncertainty that is prohibited in Islamic finance?
AK, Standard Chartered Islamic banks would still be different
because they would be concerned only with the real economy and
would encourage saving and discourage speculation. So this is how,
done correctly, Islamic banking will fundamentally differentiate
itself from the current capitalistic system. I will give you an example.
The approval from the Shariah board for derivatives is to match
trade by trade 60% of your last three years’ imports, 50% of your last
From · EUROMONEY · December 2008
five years’ exports or on a transaction-by-transaction basis.
ND, Trowers & Hamlins The differential must be ideology, because
once the range of products is the same or broadly comparable, once
the returns are the same or broadly comparable, then what must
be the defining characteristic in terms of whether you invest in a
Shariah-compliant manner or whether you invest in or buy conventional banking products must be your faith, your ideology – but I am
not a Muslim, so I am perhaps not the best person to ask.
When I give my money to a bank, I don’t really care what they
do with it. That’s the difference. They say they will pay me X, and
I say: ‘Well, fine, you pay me X’. When you put your money in a
bank, you want to know what they are doing with it, how they are
managing it, how they propose to produce the return that they
have promised you.
AAK, GBCorp The key difference is fundamental in nature. The Islamic
economic model has been developed over time, based on the rulings
of Shariah on commercial and financial transactions. In this excerpt
that I read recently by Dr Iraj Toutounchian, a professor of economics at the Az-Zehra University in Tehran, he mentions that interest is
rewards to money and profits are rewards to capital investment. So the
main difference between conventional banking and Islamic banking
is that one is interest-based and the other profit-based.
Islamic commercial jurisprudence consists of principles and rules
that must be observed for transactions to be acceptable in Islam; and
the Islamic law of contracts is at the heart of this. One important
principle is contractual certainty. Under this body of law, uncertainties or ambiguities that can lead to disputes may render a contract
void under Shariah.
NNT, DIFC For me, I actually see it as a fairly simple objective. Islamic
finance should reflect the genuine demand of the mass market that
regardless of religious belief it is a financial system that takes into account ethics and responsible financing because that affects us all. It
is a universal value that anyone can appreciate, an issue of substance
over form. Creating wealth is not a problem but doing so in an unbridled manner leads to various problems. The challenge is putting
together these sets of objectives into a workable system – Islamic
finance is an industry still in that process.
Sukuk market developments
MNA, AAOIFI How do you see the future of sukuk in light of some of
the turbulence taking place in the financial market and in our own
Islamic market in terms of fatwahs regarding sukuk? What is your
timeframe and your estimates for a real secondary market to exist for
From · EUROMONEY · December 2008 sukuk?
KH, CBB I think sukuk will continue to grow, but of course the timing
now is not right for any issue of sukuk because of the liquidity concerns in the market as a result of the crises. But I see a brighter future
for sukuk.
AAK, GBCorp Today, the Islamic financial industry is worth $700 billion of assets. The market for sukuk alone accounts for $100 billion.
According to a recent report from Moody’s, sukuk structures are
evolving rapidly, with an important degree of innovation. The market is increasingly moving away from the lease and lease-back sukuk
structures of the first generation and towards structured sukuk. Underlying assets eligible for sukuk schemes have witnessed increasing
diversification. The number of issuers has also grown, both within
the Muslim world and beyond its natural borders. I see sukuk growing due to its ability to cater to market needs.
IAA, IIFM The future is definitely bright, but we have to look at the
role of sovereigns. For example, in the case of sukuk the sovereign issuance is less than 10% of the entire sukuk issuance and to keep the
market growing – and to create benchmark issues on which to build
a secondary market as well as a yield curve – we need much more
sovereign issues than what we have at the moment. We also need
continued help from all the Islamic infrastructure institutions such
as IIFM, AAOIFI, IFSB to make the Islamic finance system more robust. And at the same time scholars can further review the product,
document it, etc, and make further improvements if required.
MNA, AAOIFI But it is still the case that these sukuk are not traded?
AK, Standard Chartered They are not traded because you don’t have
enough instruments and you don’t have the market depth. Who are
most of the buyers? It is basically either Islamic institutions or the
majority of them have been in the conventional market that wanted
to have the security. I think in the secondary market you need repeat
issuances as well by the same issuer so you have established shirkah
(sharing), so I can continue to have exposure to you either at the
short end or the long end. This is one fundamental problem.
Two, when you do a sukuk, the primary takers of the sukuk are
Islamic banks that are liability surplus and asset deficient. There
is no motivation to sell an earning asset at any price, so they will
hold it. As policy in Standard Chartered, any issue that we bring to
market will make a market for it. The issue of making the market is
that we must have stock to make a tight price, so if the issue size is
small and if I can’t source the issue from the market, and I get a very
small allocation, so I keep it for price tightening right after the issue
when I release, after that if I can’t take a paper from the market then
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Islamic finance debate
the bid-offer spread widens. So it needs repeat issuances by the same
issuers for different tenors. It needs more counterparties to trade
starting now.
ND, Trowers & Hamlins Yes. There are very few market makers. There
are few willing sellers. And as Afaq has mentioned, Islamic banks
are obviously snapping these sukuk up to address their asset liability
mismatch. It gives them a nice three-, five-, seven-year asset earning
supervisory boards in sukuk transactions. The pronouncement also
reiterated the stipulations contained in our existing Shariah standard on sukuk.
NNT, DIFC Sukuk has a good future for as long as the credit quality
is maintained by market participants. Notwithstanding the current
crisis, we would still see growth when the dust settles. It is very clear
that demand exceeds supply by far.
them a good return that they can arbitrage against the shorter-term
returns that they are paying out.
It will also be interesting to see what is going to happen to the
market following the AAOIFI pronouncement because that is obviously excellent news from a Shariah-compliance standpoint, but it
introduces an element of risk that the conventional marketplace
and the conventional buyers of the instrument have hitherto not
had to face because they knew that, in a default, they get a full
pay-out.
With the prohibition of that full pay-out, and with the termination instead being tied to market or fair value or an agreed value, you
are introducing an element of equity risk to what has hitherto been
regarded as a fixed-income product, and the conventional market
will be very wary of that and not particularly receptive to it. This is a
problem for the market because they have been the big buyers of the
headline issues and they are not going to want to buy a product that
is becoming more of what it should be, which is more of an equity
instrument than a debt instrument.
AK, Standard Chartered A slightly different take. The ijara (leaseto-own) sukuks will be used for treasury risk management, money
market. The musharaka (partnership) and the mudarabah sukuk will
go in the investment portfolio.
MNA, AAOIFI Let me explain the recent AAOIFI pronouncements.
Our Shariah Board – which is acknowledged as the foremost authority in Shariah for Islamic finance – was concerned over Shariah
compliance for a sizeable portion of the non-ijarah sukuk market.
For the ijarah sukuk market, which is the predominant part of the
overall sukuk market, there was no concern though.
We deliberated the issues regarding the non-ijarah sukuk with
more than 40 Islamic finance practitioners, representing some of the
leading investment banks, legal firms, and accounting and auditing firms, together with members of our Shariah Board. As a result
of the deliberations and extensive consultations, we published
our pronouncement, which gives additional guidance on sukuk
issuance, particularly on the application of purchase undertaking,
the application of fair value principles, and the roles of Shariah
What I would like to see is more initiatives that encourage trading. There ought to be a regulatory framework for trading – not just
trading domestically but trading across borders as well. If a treasury in
Hong Kong wants to buy a sukuk issued in Brunei, it should be able to
do it immediately.
And there also ought to be better sharing of information on
trading. Real-time information on prices, and there has to be clear
benchmarking, which means more prime rated issuance is required.
ND, Trowers & Hamlins I’d just like to add the point that because
sukuk can be on balance sheet that people get a little ahead of
themselves when talking about the sukuk market as a driver for securitization. For a true securitization market to develop I think we
need legal change, because the problem that we have in this region
at the moment is the difficulty of achieving true sale – the lack
of distinction between legal ownership of an asset and equitable
ownership of an asset.
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Need for standardization
MNA, AAOIFI One key observation is the lack of homogeneity in
Islamic finance products and practices. This is partly due to the diversity in Shariah interpretation across and within the different regions
throughout the world. How would you respond to that?
AAK, GBCorp As I mentioned earlier, Islamic banking is evolving and
these are some of the challenges that Islamic banking faces as it goes
global. Shariah scholars’ interpretations and understanding of the
law can and do differ between Shariah scholars. Certain contractual
terms deemed to be valid under Shariah by the scholars of one school
of fiqh (Islamic jurisprudence) may not be acceptable to scholars from
another school. This has had significant implications for the development of Islamic finance. But with the willingness to have standardized practices and products in the Middle East, Islamic finance will
certainly evolve and continue to establish a global presence.
NNT, DIFC It is a big issue. But it boils down to the effectiveness
of those who are driving consensus. Now, the only way you can
actually do that is through collaborative efforts between regulatory
bodies, the marketplace and standard-setting bodies such as AAOIFI
From · EUROMONEY · December 2008
and IFM. So we need collaboration, less repetition of work and more
transparency. At a practical level, standardization would ensure
scholars and market players avoid having to go through an approval
process for products that are already widely used in the market.
Because that process is costly, takes time and takes away valuable
resources such as scholars’ availability – less time spent on repetitive
process would allow more time spent in developing products and
a need to complete standardization in three areas: accounting,
regulation and contracts documentation. In accounting, we wish
to see AAOIFI standards to widely used. In regulation, we need an
international standard along the lines of a Basle committee with
standards on several regulatory tools and approaches. Last but not
least, we need to also see minimum standards on master agreements
in Islamic products.
infrastructure that would further enhance the industry.
ND, Trowers & Hamlins I always wonder if this issue is actually overplayed. I think that the core products and the key issues surrounding
the implementation of those products are fairly settled now. There
will be differences of opinion on more esoteric products, in terms of
product development, and I think that will always be the case.
But in terms of what Nik was saying, I guess that the primary
purpose as the originator of the product – as the bank or the institution – of standardization, is reduction of cost via commoditization.
So I cannot be continually thinking: ‘Is the Shariah scholar going to
argue about this? Is the bank going to have a problem with that?’ But
I think that that issue is exaggerated.
MNA, AAOIFI Nevertheless, some observers say you can still walk
into a bank and you see a mudarabah tool or a murabaha product
and walk into another bank on the same street and they give you
completely different characteristics and parameters of the same
product with the same label.
AK, Standard Chartered I absolutely agree on that. Standardization
reduces my costs, it improves my turnaround times, it reduces my
legal and reputational risk, so I am all for standardization. But there is
a case to be made for innovation.
ND, Trowers & Hamlins And remember, decisions change in the
conventional legal system as well. Old decisions are overturned and
of course there are significant differences in the legal systems of the
countries in Europe – some being based on common law principles
and others having civil or code-based systems.
IAA, IIFM Standardization is clearly very important, but in order
to continue the process of innovation and growth you should not
standardize each and every product or document or process – you
have to prioritize and see what the market requirements are. Certain
products will remain tailored between a few institutions, ie bilateral,
and that is how innovation happens.
AAK, GBCorp Standardization is a critical issue. But it is also important
to understand that in trying to stay ahead of innovation, regulation
should not get so stringent that it stifles innovation.
KH, CBB In the short-term perspective we see that there is now
I agree that we should not over-impose standardization as it will kill
creativity and we should give the market an opportunity to differentiate in terms of product. As you know, in Islam as long as your scholar
says yes, then he is responsible for that answer.
MNA, AAOIFI But the public will be affected too.
KH, CBB Well, of course, but if he says yes, then effectively he is the
one who is taking the risk. Basically you are placing this decision on
his fatwah because that is the relationship between him and God.
Now you will continue to see different fatwahs in the market but
over time you will see master documentation being developed that
will be used widely and will embody the standard structure.
MNA, AAOIFI So you don’t need a scholar? You wouldn’t need a
scholar to give you fatwah?
KH, CBB I think we will continue to need scholars. Ten years ago
this product was not permitted, now it is permitted. It also depends
on the way you present the structure and the documentation
to your scholars. If you present them well, then you get a good
chance of a review, but if you don’t present it well, you might get a
different answer.
AAK, GBCorp Let me clarify. You do not need a Shariah scholar to
create a fatwah but what you do need is a Shariah board to create the
parameters of functioning in an Islamic bank. It is important to realize that realism and theory can be sometimes detached, therefore
creating the need for regulating Shariah scholars to allow them to
think in a banking perspective rather than a scholarly perspective.
Islamic finance institutions rely on Shariah committees of scholars for advice and instruction on their services and, as the number of
institutions increase, the relatively small number of scholars is being
stretched, and there is pressure to ensure that a new generation is
being groomed to handle the increasing demand. Nevertheless,
despite the advances in Islamic finance, scholars with the ability
to integrate both systems, conventional and Islamic, are needed
and there is clearly scope for more education and training. On the
positive side, there is a huge wave of interest in Islamic finance and
people are studying more about the industry, it is a sign that Islamic
banking and finance is evolving.
From · EUROMONEY · December 2008 www.euromoney.com